Mid Week Bond Update

U.S. Municipal Bonds: Different Drumbeat

The flattening of the yield curve for munis might have a different significance than what's been seen in the yield curve for Treasuries.

U.S. Municipal Bonds: Similarly Flat, Different Drumbeat

Though it lasted only six days, the short-end inversion of the U.S. Treasury yield curve in March made many investors hypervigilant.

One of the richest veins of anxiety has been in U.S. municipals, where the 2-yr 10-year spread has dropped as low as 0.37 percentage points on March 31, the lowest it's been since 2017 -- at about the same time the Treasury 3-month / 10-year spread was reaching its inverted low of ‑0.0663 percentage points.

But while similar in effect, the dynamics behind the two reductions are not quite the same. The muni market is much more fragmented than the market for Treasuries; even within credit rating bands, terms of individual issues can vary widely, making it difficult to draw general conclusions about bonds with the same ratings, no less bonds with lower ones.

Economic conditions are substantially different from the last two times this measure dropped this much. Consider that as the tech bubble burst in 2000, the Fed slashed its target rate from its high of 6.5% to as low as 1.0% within 2-3 years, bringing the inflation-adjusted rate well into negative territory. And in the aftermath of the 2008-9 global financial crisis, the Fed again brought rates well below the prevailing rate of inflation – this time, leaving the rate near zero and putting further easing plans into effect.

But this point in the U.S. cycle differs from the others, as noted in a recent piece by Western Asset. The firm sees inflation as low and perhaps heading lower, making the current inflation-adjusted rate only somewhat greater than zero, with the Fed showing little determination to lower rates – at least for now. What’s more, other specific pricing anomalies could be affecting the 10-year part of the muni curve.

Municipal Curve Slope, Inflation and Rates: Each Time, It's Different

Chart courtesy of Western Asset. Sources: Thomson Reuters, Bloomberg, Bureau of Labor Statistics, Western Asset. As of 31 Mar, 2019. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

On the rise: UK corporate bond issuance

After a halt due to the uncertainties surrounding the former March 29th deadline for Brexit to go into effect, some UK borrowers are taking advantage of the EU's extension to October 31 to raise funds -- recognizing that lenders are slightly less concerned about market uncertainties than they were earlier in the year. So far, two borrowers have successfully raised a total of 452 million British pound- equivalent this calendar year; two other companies (William Hill Plc and Tesco Plc) announced plans to raise 350 million pounds ($453 million) each in sterling bonds. EG Group Ltd. is selling 1.35 billion euro-equivalent bonds denominated in euros and dollars. The last UK company to sell a bond was Playtech Plc, pricing a €350 million note in February, a month before the first Brexit deadline.

The resurgence of borrowing, though real, isn't overwhelming yet. By this time last year, eight borrowers had issued about 2.8 billion pound-equivalent of bonds, five times as much as this year so far.

On the slide: Argentina's shale-oil prospects

Like the U.S., Argentina has a region with good prospects for shale-oil production – the Vaca Muerta formation, with about 1,000 wells drilled since the beginning of development over six years ago. But also like the U.S., exploration and production need large volumes of investment capital – which is a problem in Argentina's current financial crisis, which is driving up market yields to the point that drillers can't afford to borrow. Argentina's Energy Secretary Gustavo Lopetegui pointed out in a recent interview that in the current yield environment, it's "very difficult" to justify any project, despite the stated good prospects for the area under development. The Bloomberg Barclays US Dollar Argentina Aggregate Index currently has a yield-to-worst of 12.76%, and has generated a total return of 0.83% year to date, despite the commanding yield.

All data Source: Bloomberg as of April 23, 2019 unless otherwise specified.

Definitions:

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities. .An Inverted yield curve is a market condition in which yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.

A spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.

The Consumer Price Index (CPI) measures the average change in U.S. consumer prices over time in a fixed market basket of goods and services determined by the U.S. Bureau of Labor Statistics.

The U.S. Federal Reserve, or “Fed”, is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

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